Business Directories

‘Mena needs subsidy reform for sustainable development’

Doha, July 16, 2014

The Middle East and North Africa (Mena) region accounted for nearly half of the $492 billion global spending on energy subsidies, making the burden on public resources quite substantial, according to a report.

The QNB Group noted that while total spending on energy subsidies in Mena reached 8.6 per cent of GDP in 2011, there was a significant variation among the countries in the region.

Iraq and Egypt’s spending on energy subsidies reached 11 per cent of GDP, while it was three per cent in Tunisia. Within the GCC, it was 10 per cent in Saudi Arabia, while the UAE was six per cent and Qatar three per cent.

Therefore, countries in the Mena region could benefit from reforming their subsidy systems, said the report.

The large spending on subsidies consumes a large portion of public resources rendering their unsustainable even in the short-run for some countries. For energy-importing countries, subsidies tend to create external imbalances, increasing the risk of a balance of payments crisis, it said.

The subsidies could also hamper economic growth as the government directs its resources away from growth-enhancing spending towards paying subsidy costs. In many countries in the region, subsidy costs far out-strip spending on education or health. This can have long-term consequences on the economic welfare of the region’s populations.

Moreover, subsidies make the cost of capital artificially cheaper relative to labour wages, creating incentives for firms to switch from labour to capital-intensive industries. This leads to lower job creation in a region with high unemployment and a young population.

The empirical evidence suggests that the benefits of energy subsidies tend to be skewed towards high-income sectors of the population, with the richest of the population – about 20 per cent in developing countries – estimated to receive six times more in fuel subsidies that the poorest 20 per cent.

The IMF estimated that the richest fifth of the population in Egypt captured 71 per cent of the benefits from diesel subsidies compared with one per cent for the poorest fifth.

Other distortions created by subsidies beyond the direct economic consequences includes keeping fuel prices artificially below the price determined by market forces, leading to overconsumption of energy with adverse impact on the environment, health and traffic congestion. It also creates incentives for smuggling as the domestic price is pushed below prices in neighbouring countries.

The IMF has recently documented 28 episodes of energy subsidy reforms worldwide. Five of these episodes failed to achieve their objectives while 11 others were only partially successful. Among the successful reform programme, two measures were particularly crucial.

The first is appropriate phasing-in of price increases. Too fast an increase in energy prices can generate a backlash against reforms. This is what led to the failure of the Mauritania attempt to reform energy subsidies in 2008. Conversely, removing subsidies too slowly can result in partial and incomplete reforms.

Second, it is important to provide social safety nets to the poor as subsidies are removed. Despite capturing a smaller share of the overall benefit, poor households would still be impacted both directly, as subsidies are removed, and indirectly as their removal is likely to result in higher consumer prices, squeezing the real income of poor households.

The targeted cash transfers to the poor should replace energy subsidies but these tend to be complex to administer. However, the positive experience of Iran in 2010 shows that even indiscriminant cash transfers to all segments of the population can play a key role in the success of the reforms and in redistributing the resources from the rich to the poor.

Mena countries could, therefore, benefit from reforming spending on subsidies to rebalance their economies, boost growth and employment and support more sustainable and efficient economic development, the report added. - TradeArabia News Service